1
Q
What work does a RX analyst do?
A
- Create/update screens
- Create/update profiles
- Work on pitches
2
Q
How do deals come to RX shops?
A
- Existing relationships of the MDs
- Precedent transactions / previous experience of the shop
3
Q
What is usually included in an RX pitch?
A
- Executive summary
- Overview of the financial situation
- 2-4 potential restructuring solutions
- Appendix (additional analysis, e.g. liquidity roll forward)
4
Q
What are some of the tools that RX analysts use?
A
- CapIQ: company financials, credit ratings
- Reorg: everything RX – commentary, cap tables, credit doc analysis, etc.
- Debtwire: commentary and fact sheets and restructuring cases
- PACER: Chapter 11 legal filings
- Trace: debt trading volumes and bond pricing
5
Q
What are the characteristics of a distressed company in need of restructuring?
A
- Shrinking liquidity (low interest coverage ratio)
- High leverage ratio
- Fully drawn revovler
- Accounting: increasing accounts payable, declining EBITDA, etc.
- Debt trading below par, especially secured debt
- Decreasing equity price, if public
- Recent credit rating downgrades
- Limited secured basket capacity
- Upcoming maturity walls that are unlikely to be refinanced
- Butting up against covenants (nearing technical default)
- Increasing amount of distressed hedge funds buying up potentially impaired classes
6
Q
What are reasons why a company becomes distressed?
A
- Difficult macroeconomic conditions (e.g. GFC)
- Industry cyclicality (e.g. oil and gas)
- Poor business strategy
- Uncompetitive product/service offering
- Mass tort claims (litigation)
- Poor capital allocation (e.g. execessive share repurchases, a bad acquisition)
- Poor management
- Loss of major customers (such as through their own bankruptcy)
- Mismatched capital structure
7
Q
If a company does file for bankruptcy, what precipitates that?
A
- Fully drawing down the revolver
- Cash preservation measures (e.g. workforce layoffs, cutting back on capex)
- Retaining advisors
- Missing out on interest payments
- Technical default
8
Q
What can a company in distress do to rightsize?
A
- Exchange: exchange existing debt for new debt (typically at a discount)
- Extend: extend maturity walls on existing debt
- Change of terms: change terms on existing debt (e.g. reducing the interest expense, toggling to PIK interest)
- Sell non-core assets to raise cash
9
Q
What is a cap table?
A
A table that displays a company’s debt securities and their face value, market value, credit rating, coupon rate, and maturities, and the company’s liquidity; leverage and interest coverage ratios are also included
10
Q
What are maturity walls?
A
Upcoming dates that represent when a company needs to refinance or pay off certain tranches of its debt
11
Q
How do you determine how much liquidity a company really has?
A
Liquidity = cash - restricted cash + revolver capacity - amount drawn - letters of credit
12
Q
What is grid pricing?
A
Floating interest rates on revolvers that change depending on the amount of the revolver that has been drawn down (typically an increase in interest rate)
13
Q
What is a springer or “spring forward”?
A
A provision in credit docs (typically secured debt) that allows a specific security to spring forward in maturity prior (90 days) to another security (typically unsecured debt) if that security has not been refinanced by a certain date
14
Q
What things would you expect to change the most for a distressed company on the three financial statements?
A
- Capex: likely to be significantly reduced to only maintenance capex
- Decreasing or negative working capital (decreasing operating assets and increasing operating liabilities)
- Increasing one-time advisory/legal fees
15
Q
What are the elements of a traditional capital structure?
A
- ABL credit facility (revolver)
- Term loans (TLA, TLB)
- Secured debt (1L, 2L)
- Unsecured debt
- Subordinated debt
- Mezzanine debt (convertible bonds, preferred equity)
- Common equity
16
Q
Do secured creditors always get treated as secured?
A
Secured creditors are entitled to secured claims equal to the value of their collateral, which can decline in value; in some cases, if the value of the secured claim exceeds the secured collateral, the difference is treated as a deficiency claim, which has the status of a general unsecured claim
17
Q
What are leverage and interest coverage ratios?
A
- Leverage ratio = debt / EBITDA
- Interest coverage ratio = EBITDA / interest expense
18
Q
Why does the Efficient Market Theory not apply to distressed debt?
A
- Information asymmetry: not all information is pubicly available or easily accessible to all investors
- Irrational agents: certain lenders, such as banks, must abide by strict financial restrictions, which typically include rules prohibiting holding non-investment grade securities; as such, given the nature of distressed investing, this is a common occurence, so many of these lenders will be forced to sell, even if it may not be in their best interests
- High transaction costs / illiquid markets: given the limited number of players, transaction costs are high and wide bid-ask spreads often form
19
Q
Why would a distressed fund want to own at least 50% of any issue?
A
Modifiying (most) indentures within credit docs require only a simple majority, so owning 50% of the issue allows the fund to potentially effectuate a better return by editing their credit docs, or prevent another party from editing the credit docs and harming their recovery (e.g. priming)
20
Q
What are cooperation agreements and why do they matter?
A
Binding agreements between creditors to work together on potential restructuring plans, vote in favor of any future group-approved restructurings, and reject proposals not supported by the group; these give creditors greater leverage in out-of-court restructurings and make it difficult to borrowers to gain a better deal by fragmenting creditors and incentivizing creditor-on-creditor violence; 2024 saw increasing adoption of cooperation agreements (LM 2.0)
21
Q
What acceptance rate do exchange offers need (out-of-court)?
A
Around 90%
22
Q
What can a company do from an out-of-court perspective when it is unable to make interest coverage?
A
- Toggle to PIK interest
- Issue discount notes (and use the proceeds to pay interest)
23
Q
What happens when bank debt trades below 70?
A
The banks are typically forced to sell
24
Q
What is the zone of insolvency?
A
When a distressed firm’s board of directors must begin considering the interests of the creditors, in addition to its normal fiduciary obligation to further the interests of
stockholders
25
What is Martin Fridson's definition of distressed debt?
The security's YTM is 1000bps greater than the comparable underlying treasury
26
What is Moyer's definition of distressed debt?
Equity trading below $1 and debt is trading at over a 40% discount to par
27
How would you adjust the three financial statements for a distressed company when you're doing valuation or modeling work?
* Adjust COGS for higher vendor costs due to reduced trust from suppliers
* Add back non-recurring advisory/legal fees
* Add back excess lease expenses due to reduced trust
* Adjust working capital for receivables unlikely to be converted into cash, overvalued/insufficient inventory, and insufficient payables
* Adjust capex spending
28
How does valuation differ for distressed companies?
* Utilize the same methodologies (public comps, precedent transactions, DCF)
* Look at the lower range of multiples and make certain accounting adjustments
* Use lower projections for a DCF because you assume that a turnaround period is required
29
How would a DCF analysis differ for distressed companies?
* A greater proportion of the company's implied enterprise value will come from the terminal value since you assume a few years of negative FCF during the turnaround period
* Might include a sensitivity table on hitting or missing earnings projections, and also add a premium to WACC to make it higher and account for operating distress
30
What are the two types of bankruptcy?
* Chapter 7: a full liquidation facilitated by a court-appointed trustee
* Chapter 11: a reorganization process facilitated by a bankruptcy court with the goal of turning the company around
31
What is the fiduciary duty of the DIP?
During a Chapter 11, the company becomes the debtor-in-possession (DIP) and has obligations to both equity and debt holders
32
What is DIP financing?
Special financing that can only be obtained by debtors that have filed for Chapter 11; typically provided by existing lenders and is a very attractive investment because of its higher interest rates and super priority status
33
What can you tell me about distressed M&A?
M&A in Chapter 11 is provided through section 363 of the Bankruptcy Code, which allows the debtor to sell assets free and clear of all liens, through an open outcry auction with a stalking horse bid installed
34
What is a liquidation valuation?
A valuation that determines the value of the debtor if it underwent a full sale process; used to determine if a reorganization is in the best interest of the debtor and its creditors; typically results in much lower valuations given the fire sale nature of full liquidations and the fact that the whole is greater than the sum of its parts
35
What are the pros and cons of Chapter 11 (for the company)?
Pros:
* Stay on interest payments, repossession of collateral, vendor/supplier claims, litigation, etc.
* Assumption/rejection of executory contracts
* Access to DIP financing
* Section 363 asset sales
* Greater negotiating power
Cons:
* Very expensive (advisory/legal fees)
* Bureaucratic and limited flexibility (court approval is needed for most things)
* Loss of privacy (public court records, frequent financial reporting)
36
What are the four major steps of Chapter 11?
1. Restructuring of the debtor’s operations by asset sales and contract assumptions and rejections
2. Development and dissemination of a proposed plan (POR)
3. Voting on the plan by the claim and interest holders
4. Confirmation of the plan by the bankruptcy court
37
What is the difference between a section 301 and section 303 in Chapter 11?
* Section 301: voluntary petition filed by the company
* Section 303: involuntary petition filed by the company's creditors or an indenture trustee
38
What is included in a plan of reorganization (POR)?
* Plan must designate all classes of claims and classes of interest
* Plan must specify any class of claims or interest that are not impaired under the plan (deemed to accept)
* Plan must specify the treatment of any class of claims or interest that are impaired under the plan
* Plan must provide the same treatment for each claim or interest of a particular class unless by requisite vote holders agree to a less favorable treatment
* Plan must provide the adequate means for the implementation of the plan (feasability)
39
What classes do not get a vote on the POR?
* Unimpaired classes: classes that receive a full recovery are deemed to accept
* Fully impaired classes: classes that receive zero recovery are deemed to reject
40
What is needed for a POR to be approved?
In each voting class, two-thirds of the notional amount and one-half of the debt holders must agree to the plan
41
What two valuations are done in the confirmation of the POR?
* Liquidation valuation: the value of the company if a full liquidation was effecuated
* Going concern valuation: a standard valuation of the company
42
What are the four legal tests for the confirmation of the POR?
* Best interests test: is the plan in the best interest of the creditors (liqudiation valuation vs. going concern valuation)
* Good faith test
* Feasibility test: can the plan reasonably be implemented
* Consent / cram-down: the court can force, or cram-down, creditors in a class to accept the plan, given that 1) at least one impaired class agreed to the plan (not an individual creditor in the class, but an entire impaired class), 2) the plan is "fair and equitable" (complies with the absolute priority rule), and 3) the plan does not unfairly discriminate against any impaired class
43
What is the rule of absolute priority?
A class cannot receive any kind of recovery before classes senior to it have received a full recovery; value in a restructuring flows down into "buckets", and a bucket cannot be filled with anything before the buckets before it are fully filled
44
When does the absolute priority rule not apply?
When a class of claims (senior in the capital structure) that has not been made whole consents and allows a more junior claim to receive some kind of recovery
45
Why facilitate asset sales under section 363 instead of Chapter 7?
* Management has control over the sale process (with the assistance of its advisors)
* Specific assets can be sold free and clear of all liens in a controlled manner, without needing to liquidate the entire business
46
What is substantive consolidation risk?
The bankruptcy court is afforded the power to consolidate liabilities of different entities into one entity; this changes the value of creditor claims by invalidating any priority a claim may have had due to corporate structure, thus potentially altering the recoveries of affected creditors
47
What is critical vendor payments risk?
Critical vendors, such as key suppliers, are essential to the company's survival and must be paid in cash throughout the Chapter 11 process to ensure that the company can continue operating
48
What are the bondholder committees and what are their rights?
In out-of-court scenarios, bondholders band together to form a bondholder committee that negotiates with the company, with the help of advisors (creditor-side mandates); bondholder committees cannot force anyone to do anything, but receive greater bargaining power by working together and have access to non-public information
49
What are the downsides of being on the bondholder committee?
Limited flexibility -- by gaining access to non-public information, committee members must disclose when they enter new positions and sell existing positions, and cannot share the non-public information
50
What is priming?
When a new piece of the capital structure is added above existing pieces, thus pushing existing pieces to a lower priority (and potentially recovery level)
51
What is one way to add debt when there is insufficient asset coverage?
Preferred equity or convertible bonds
52
What is voidable preference?
Unnecessary, preferential treatment of certain creditors prior to Chapter 11 that can be unwound by a bankruptcy court; there is a lookback period of 90 days for voidable preference (for insiders, the lookback period is 1 year)
53
What is fraudulent conveyance?
Movement/maneuver of assets by the debtor, prior to Chapter 11, that have the effect of placing them out of reach of creditors; in other words, the debtor did not receive "fair value" in the transaction, or was insolvent at the time of the transaction
54
What is credit bidding?
During section 363 sales, secured lenders can use the value of their secured collateral as part of their bid; e.g. a lender with $50mm in secured collateral can make a $80mm bid on an asset with a $50mm credit bid plus $30mm in cash
55
What is adequate protection and how can it be provided?
A right bestowed to secured creditors under certain conditions during a bankruptcy that protects the value of their collateral; it can be provided in three ways:
1. Cash payments, to the extent that the value of the creditor's collateral depreciates
2. Additional liens to make up for any decreases in the value of the creditor's collateral
3. Granting such other relief as will result in the realisation of the “indubitable equivalent” of the creditor’s interest in the collateral
56
When does the requirement to demonstrate and provide adequate protection arise?
* When the debtor requests to use, lease, or sell the collateral
* When the debtor requests to grant a lien of equal or superior status in favor of another creditor, as is common when securing DIP financing
* When secured creditors request to have the automatic stay lifted by the bankruptcy court
57
What is the period of exclusivity?
The period, at the beginning of Chapter 11, during which the debtor has the sole power of drafting and proposing a plan of reorganization (120 days, can be extended up to 18 months)
58
What is the fulcrum security?
The security highest in the capital structure that is impaired and is not paid in full, and thus receives a significant portion of the post-reorg equity
59
What is an equity rights offering?
An opportunity for prepetition lenders and shareholders to purchase a fixed amount of the company's post-reorg equity, typically at a discount and backstopped by a backstop party
60
What are warrants?
Right to buy stock at a certain strike price
61
What are liquidation trusts and when are they used?
When a substantial portion of a debtor's assets have been liquidated in Chapter 11 but some valuable assets still remain, a liquidating trust that holds these assets is formed to continue overseeing distributions to creditors after exiting court; other use cases:
* When there are lawsuits that creditors want to pursue against third parties to increase overall recoveries
* Resolution of claims against the estate
62
What has Sarbanes Oxley done for equity holders?
Allows the SEC to move the equity claim and prime subordinated and unsecured bond claims when fraud has occurred
63
What are the pros and cons of a section 363 sale?
Pros:
* Expedited process
* Avoids "side-show" issues that may occur in plan confirmation proocess; focus is on the debtor's sound business judgement and fair price
* Purchaser can receive assets without negotiating with the entire creditor body
* Can leave behind liabilities
Cons:
* Requires public marketing and auction process (lack of control)
* Outside bidders must be allowed to participate
* Does not fully resolve all issues -- typically requires a Chapter 11 plan to reorganize remaining assets and pay off liabilities
* Limited flexibility
* Potential loss of tax attributes
64
What is equitable subordination?
Section 510 of the Bankruptcy Code provides that claims may be subordinated (lower their priority), on the conditions that:
* The creditor has engaged in inequitable conduct
* The misconduct resulted in injury to other creditors, and
* Equitable subordination is generally consistent with the Bankruptcy Code
* America Lumber Co. (1980) -- lender bank with a lien on accounts receivable induced the debtor to sell inventory to convert value to accounts receivable, so-called "feeding the lien"; the bank's claims were equitably subordinated
65
What is preference?
When, before filing for bankruptcy, a debtor pays/gives a creditor more than the creditor would have received in the bankruptcy
66
What is recharacterization?
The bankruptcy court can use equitable powers under section 105 of the Bankruptcy Code to recharacterize "debt" as equity; if parties appear to have an "investor" relationship with returns tied to future performance, a purported loan is likely to be recharacterized as equity
67
What is a release, and what types of releases exist?
Section 1123 of the Bankruptcy Code serves as the basis by which a debtor can seek to obtain various forms of releases in a POR from certain types of potential claims and causes of action
* Debtor release: debtors release certain parties from certain types of potential claims and causes of action
* Third-party (non-debtor) release: certain third-parties (typically a debtor's creditors) release certain other non-debtor parties from certain types of potential claims and causes of action
68
What are the two types of third-party releases and how do they work?
* Consensual third-party releases: releasing parties have the ability to opt into or out of the releases
* Non-consensual third-party releases (no longer allowed after *Harrington v. Purdue Pharma L.P.*): releasing parties do not the option to opt into or out
69
What are CDOs and CLOs?
Collateralized debt obligations and collateralized loan obligations; entities that seek to earn returns by making leveraged investments in a portfolio of high yielding bonds (CDOs) or highly leveraged loans (CLOs); these entities consist of a waterfall of different tranches, where the highest tranche receives the highest credit rating (almost always AAA) because it has the first claim on the income stream, while equity sits at the bottom
70
What are the two main groups of syndicated loans?
Revolvers and term loans
71
What is the investment grade rating cutoff?
BBB- for S&P and Baa3 for Moody's
72
Why are credit ratings not that great of an indicator for distress?
They are lagging indicators
73
What is a covenant, and what are the three broad types?
A rule laid out in the indenture and credit docs by which a company agrees to operate as part of the terms of the loan/bond
* Affirmative covenants outline something the company must do
* Financial/maintenance covenants typically outline certain financial ratios that the company must maintain
* Negative covenants restrict what a company can do
74
What are two priority related covenants, and how do they work?
* Restricted payment provisions: provisions that limit the company's ability to distribute assets to third parties, in an effort to prevent credit support erosion
* Negative pledge clauses: in the case that the debtor gives security interest in any of its assets to any lender, this contract term requires the debtor to include existing unsecured debt as beneficiaries of that pledge
75
What is technical default?
When a company is in violation of one or more of its covenants, its lenders have the right to force it into an involuntary Chapter 11 process
76
What are the four methods to distinguish credit priority?
* Grants of collateral
* Contractual provisions
* Corporate structure
* Maturity schedule
77
What is credit risk, capacity, and support?
* Credit risk: the probability that contractual payment terms of a loan/bond are breached
* Credit capacity: the amount of debt that a firm's operating cash flows can service
* Credit support: the source of funds used to repay the debt (typically collateral or cash)
78
What is a revolver?
Revolvers are secured lines of credit that allow companies to borrow a discretionary amount of money, up to a set limit, similar to a credit card; it is a form of asset-based lending and sits at the very top of the capital structure
79
How do revolvers work?
Revolvers are secured against a borrowing base, typically accounts receivable and inventory, e.g. 50% of inventories, 75% of accounts receivable, which sets the true ceiling of the borrowing base (the lessor of the set limit and the value of the borrowing base); if the borrowing base declines below a certain level, the company must repay the revolver or have it resized; most revolvers also become more restrictive as a company becomes increasingly distressed and starts violating certain indicators of distress (e.g. leverage ratios)
80
What are borrowing bases?
The collateral of asset-based lending facilities that represent how much can be borrowed at a given time
81
What is asset coverage?
Assets / debt, an estimate of a firm's credit support
82
What is LIBOR/SOFR?
The interest rate used as the base rate for floating rates; SOFR (Secured Overnight Financing Rate) is a measure of the cost of borrowing cash overnight, and is effectively the risk-free rate
83
What does *pari passu* mean?
On equal footing; refers to two debt instruments being equally ranked in the capital structure
84
What does *pro forma* mean?
As a matter of form; refers to financial statements that have been adjusted to reflect certain adjustments or new mergers/acquisitions
85
What is a bond's yield-to-maturity (YTM)?
The bond's annualized rate of return, taking into account the price paid, the coupon payments, the principal payments, and the amount of time to maturity; or, the rate at which you discount the future cash flows (coupons and principal) such that their present value aligns with the bond's price
86
What are the differences between Term Loan A and Term Loan B?
* Term Loan A: tends to be held by commercial banks; better terms, lower maturity, and more amortization
* Term Loan B: tends to be held by institutional investors; rarely has meaningful amortization
87
What is a tender offer?
When a company conducts an open market repurchase of its debt, typically at a significant discount to par value, either to obtain a simple majority to modify the credit docs, or reduce interest expense (if it is a low rate environment, some companies may borrow money at a lower rate to buy back their higher rate debt)
88
What is an amend and extend agreement?
A agreement between the debtor and a creditor that alters the credit docs (e.g. increasing interest rate or doing a term loan pay down) in return for pushing out the maturities
89
What is the fixed-charged coverage ratio (FCCR)?
FCCR = (EBITDA - capex- cash taxes) / (interest expense + mandatory debt repayments)
90
What are some ways that a company can preserve cash if it's facing financial distress?
1. Sale leasebacks
2. Sell non-core assets
3. Buy cheaper inventory
4. Hold less inventory
5. Toggle to PIK interest
6. Fully draw down the revolver
7. Extend accounts payables
8. Bill customers or clients more frequently
9. Offer discounts on overdue accounts receivables
10. Offer discounts to customers for paying in cash
11. Reduce capex
12. Reduce dividends and share repurchases
13. Switch to stock-based compensation for management
14. Reduce unnecessary SG&A expenses
15. Reduce prepaid expenses (e.g. salaries, rent)
16. Reduce the workforce
17. Reduce certain benefit packages (bonus compensation)
18. Renegotiate lease expenses down or delay payments
19. Extend maintenance cycles on equipment or try to renegotiate third-party maintenance contracts
20. Boost unearned revenue (by offering discounts)
91
What are "blockers" and what are some examples?
Blockers are provisions within credit docs that prevent specific transactions from occurring, such as a J. Crew blocker aimed at preventing IP transfers or a Serta blocker aimed at preventing non-pro rata uptiers
92
What do the terms "creation value" and "creation multiple" mean?
The creation value equals the market value of the tranche that you’re buying into, plus any higher priority debt, while the creation multiple equals the creation value divided by adjusted EBITDA; creation value / multiple represents the necessary post-reorg value of the company in order for your investment (your tranche) to receive some kind of recovery (return)
93
What are two ways to estimate a bond's yield to maturity?
* (C + (F-P)/n) / ((F+P)/2)
* (C/P) + (F-P)/n
94
What is structural subordination?
Subordination of debt as a result of its location within the company's corporate structure; *pari passu* debt that sits closer to where the assets are located are structurally superior, and are thus made whole first
95
What is a guarantee?
A contractual promise to pay the obligations of another; an agreement by an entity to securitize the debt of another entity
96
What is a nonrecourse provision?
The opposite of a guarantee; states that in the event of a default, the lender has no right to attempt to recover from certain entities
97
What is an equity cure?
A provision in certain loan agreements that gives the borrower’s parent company the right to contribute equity to the borrower in an amount that, when added to EBITDA, would result in the borrower to be in compliance with the previously violated financial maintenance covenant
98
What are cov-light loans?
* Borrower-friendly loan facilities, most likely to be found in syndicated loan transactions
* Core feature is the absence of financial maintenance tests (e.g. leverage ratio), which require the company to meet certain financial performance criteria monthly or quarterly
* Cov-lite loans have covenant packages typically of high-yield loans – includes (looser) incurrence-style negative covenants (e.g restricted payments, negative pledge clause)
* Cov-light loans generally form in credit markets where supply exceeds demand, giving companies more leveraging power and forcing lenders to make certain concessions in order to win lending agreements
99
If debt is trading below par, why might there be a positive stock price?
* Option value
* Tipping value
* Transaction costs of shorting to $0
100
If the secured debt is trading below par, why might the unsecured debt still trade above 0?
* Structural subordination (this may already be priced in)
* Temporal subordination
* Option value
* Tipping value
* Interest payments on the unsecureds
* Secured claims are deficient
101
What is channeling injuction?
In Chapter 11, a method by which the debtor can aggregate all known and future tort claims and resolve them together through the creation of a litigation trust; the amount that the debtor has to pay in litigation claims is also capped
Restructuring
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